The BaFin logo sits on a sign outside at the German bank regulator’s headquarters in Frankfurt, Germany, on Wednesday, May 8, 2019. Photographer: Alex Kraus/Bloomberg
© 2019 Bloomberg Finance LP
As the crypto community digests the news that leading firms such as Blockstack and YouNow obtained SEC approval to sell security tokens to retail investors, a German startup announced that it received approval from the German Financial Market Supervisory Authority (BaFin) to distribute the country’s first blockchain-based real estate bond to retail and institutional investors around the world.
The company is called Fundament Group, and yesterday it launched a 250 million euro ($280 million) tokenized bond offering on the Ethereum blockchain backed by commercial real estate investments in major cities across Germany. The token will conform to ERC-20 standards and be interoperable with most major wallets and transferable around the world.
According to reporting from CoinDesk, the token will be backed by five separate construction projects, three in Hamburg, one in Frankfurt and one in the university town of Jena. The portfolio, including residential, commercial and hotel properties, will total more than 680,000 square feet upon completion. The company expects to pay investors an annual dividend between 4-7% each year at the end of July until the year 2033, at which point investors will be reimbursed in full for the nominal amount of their initial purchase. Investors will be able to pay for their shares and receive dividends in fiat or ether. There is an expectation that this payout model could help drive additional demand for the token, as opposed to traditional STOs that may trade at a discount, at least early on, due to illiquid markets.
Neuschwanstein Castle (German: Schloss Neuschwanstein) is a 19th-century palace on a hill above the village of Hohenschwangau, Bavaria, Germany.
A Return to the Spirit of the Initial Coin Offering ‘ICO’
What immediately caught my attention about this offering is that unlike many tokenized real estate projects in the market, this is the first made available to individual retail investors without any minimum purchase. In this sense, Fundament’s founders are seeking to recover the “spirit of the ICO”, which at its best democratized access to potentially high-yield investments and interesting projects to anyone. Last year due to regulatory pushback around the world, but especially in the U.S., ICOs fell into disrepute and gave way to Security Token Offerings (STOs) that comply with relevant securities regulations. However, STOs disenfranchise a number of would be investors because they are typically only available to institutional and accredited investors.
Another similarity to past ICOs is that Fundament’s offering runs on top of the live Ethereum blockchain. I had the opportunity speak with one of Fundament’s co-founders, Florian Glatz, who told me that this was of critical importance to the firm. He noted, “We are very proud of that actually. They [the tokens] are going to be living, breathing, the free air of the public Ethereum network.”
That said, by building on top of the public Ethereum blockchain and making the offering open to anyone, it invites a certain degree of risk that could create challenges moving forward.
Long Arm of the SEC
First, while the company will KYC everyone who tries to purchase a token directly from Fundament, there are no restrictions on the transferability of these tokens, and the dividends, to additional users. In fact, the only restrictions on the platform right now are that investors from the U.S., Australia, and Iran are blacklisted from participating in the initial sale.
According to Florian, transferability was a requirement from BaFin to get the prospectus approved, but it is not hard to see how the SEC or other regulators could seek to investigate the company should they discover or suspect that they are selling or issuing dividend shares to U.S. investors. One needs to look no further than the SEC’s recommended enforcement action against Kik, the CFTC’s rumored investigation of BitMEX, or how the New York Attorney General is looking into whether or not Bitfinex is serving customers in the state, to understand how this is of key importance for regulators.
If something similar happens to Fundament, it could imperil some of the company’s future plans in the U.S., which they told me may include marketing the securities to institutional investors through a private placement offering.
The Grandma Problem That Comes With Embracing the Blockchain Spirit
I like to use the term “Grandma Problem” to describe Fundament’s other key challenge. It refers to a basic question regarding blockchain, identity, and bearer assets, where users can have total control over their holdings. Enthusiasts see this as a key feature and driver of adoption for crypto, but detractors question whether or not this “possession is 100% of the law” attitude will dampen widespread adoption.
When I asked Florian what would happen in the case that one of their token holders has their assets or credentials stolen, broadly speaking he noted that “In principle what we want is to allow the full benefit of the blockchain to shine, which is that investors are themselves responsible for the custody of the token…If they lose them, in principle it is their problem.” However, he did note that just because someone has their tokens stolen, that does not mean that “The legal claim is not being stolen away from the token holder”. Therefore, provided the affected individual can prove that he/she is the rightful owner of the claim/token, they can still receive the dividends. Additionally, Fundament noted that they could burn/mark the stolen token and issue a new one.
However, it is not entirely clear how an individual will be able to prove that their identity or access credentials are stolen, as this is a challenge throughout crypto. Additionally, it remains to be seen if or how fraudulently-issued dividend payments could be recovered and sent to their rightful owner.
Dealing With Forks of the Ethereum Network
Beyond these core challenges, the Fundament team will need to address other basic hurdles when they arise, such as how they will deal with a fork or split in the Ethereum network or any other blockchain they choose to support in the future, as there could be two competing chains claiming primacy. Right now, the team will follow whichever remains the “main” fork based on industry consensus. However, this may not always be clear, especially from the outset. Additionally, in the event of a fork, token holders may suddenly hold a duplicate set of tokens, but they will not receive two sets of dividends.
There is Virtue in Not Playing it Safe
With all of that said, it is important to point out that the company knew all of these challenges, and still decided to open it up investors of any size around the world. Fundament could have played it safe and limited its offering to professional investors all connected to a permissioned and closed platform, but it chose not to do so.
Additionally, they spent an arduous 7 months going back and forth with BaFin before it got approval for its prospectus, so they have already put a good deal of risk management to the platform. However, that is just a start given how uncertain they ground can be beneath crypto.
The company’s ability to anticipate and adapt to changing market and security conditions will likely determine the future of this endeavor as well as other offerings in the pipeline, which include ship management and working with a major European bank on a tokenized fund for renewable energy investments.
It will certainly be one to watch.